Nuno Fernandes is the Finance Professor for the IMD MBA Program. Always dressed with fancy suits, Nuno guides us through business cases about the global financial market. I find his classes very relevant and the lessons learnt transferable to the real world management decision making process. He is able to take a complex situation and break it down into a simple but compelling rendition and creates an atmosphere in the class that encourages students to roll up their sleeves and dig deep into the discussion together with him. His class is a perfect example of what an interactive case discussion should be like.
Here is a recent article he wrote about China.
The recent steep slides on global stock markets have been a long time in the making. As early as two years ago, it was becoming obvious that China’s rapid rise was coming to a screeching halt and leaving excessive debt in its wake. In recent weeks, the Chinese market experienced its biggest weekly fall in 20 years, tumbling more than 15%. This volatility serves as a further warning: China is still an emerging market, and it has an immature financial system.
Excessive debt is infecting every sector of China’s economy. Most large companies in China were on a roll for a number of years, in large part thanks to subsidies from the government. But, at the same time, they were not accruing capital because their activities were so dependent on subsidies. Chinese banks, which are mainly controlled by the Communist party, compounded matters by giving credit at artificially low interest rates fueling excessive debt in all of the country’s sectors.
Many of China’s largescale development projects are perfect examples of how excessive debt has piled up. Infrastructure projects, funded by subsidized loans with low interest rates, yield low profitability and weak capital productivity. Much of this credit is given through a system called “shadow banking”, meaning it does not go through normal bank loans; credit products are sold directly to individuals.
Public sector debt, particularly at the local and regional levels, has been enormous. They have gotten in their current predicament by over-relying on infrastructure projects. This cannot last forever as there are only so many roads one can build.
China also has a number of other problems. Due to the one child policy being in place for so long, its massive elderly population will have to be sustained by a much smaller working population. Social spending by the state will only increase exponentially, especially on education and health. The Chinese government also has a very high budget deficit. It is officially estimated to be at 3% or more in 2016, but how high it will really climb is anyone’s guess.
Chinese authorities face some very tough choices ahead. China is currently exhibiting many “rich country” problems while it has the budget of a “poor country”. A structural reform of its tax system is now clearly needed. If China wants a market economy, it must learn to accept the volatility that comes with any open market economy.
In the coming years, China will most likely go through a very similar scenario as Europe has in the years after financial crisis. Serious restructuring in Chinese business models and banks’ balance sheets. China’s sheer size and role on the global stage means that its problems will create risk for the global economy.
Question: How do you think companies should react to the slow down and transformations in the Chinese economy? – Please share your thoughts and comments.